The road to upward mobility is best traveled by name-droppers. While Page Three parties might be the epitome of air-kissing and social name dropping, the corporate world has its own special version. It's called Jargon Spewing. The more jargon you throw at colleagues, bosses, vendors, the more likely people will regard you as intelligent and well read and in-the-know.
So if you want to impress that snooty colleague in the next cubicle with a few well-chosen technical terms, make sense of all the jargon splashed across the pink papers, or most importantly, avoid having the blank I'm-too-dumb-to-write-my-own name kind of stare on your face when people around make complex-sounding statements at you, here's a primer:
I. Indian is expensive; Investors reconsider fresh investments
II. Inflation figures spook market
III. Advance tax numbers indicate robust quarterly corporate earnings
IV. Liquidity is tigh
V. Market is currently overbought
VI. Risk weight age on these assets is 150per cent.
VII. Market in a bear hug
VIII. There was some unwinding of long positions in the futures market.
That's a fair bit of jargon for anyone wanting to impress others. However if you are surrounded by the not-easy-to-impress types, you can atleast console yourself that reading the business papers now seems a far less formidable task than before. Happy reading.
I. India is expensive; Investors reconsider fresh investments; Valuations look attractive
Lesson 101 of Valuation comprises 4 words really - Buy Low, Sell High. Words we hear often and from people who seem unconnected to the stock markets - your grandma, the local grocer or even your family jeweler. Yet, behind this seemingly simple line, resides a very complex world. How do we know what is low, what is high and how do we measure it? The terms 'Low' and 'High' are relative terms - which means that for their value to be understood they need to be compared to something. But for that we need a common parameter of comparison. This is where P/E comes into the picture.
P/E ratios are typically used as a first-cut measure by investors to determine if a stock is overvalued or underpriced and whether it makes sense to invest in it. The P/E ratio or Price Earnings Multiple is calculated by dividing the price (of a share) by its earnings (EPS or earnings per share). It means that for a given level of performance by the company - EPS, the market has priced the stock at a particular level - P.
Take for instance a company, Xlerate, in the biotech space. Say, the company's stock price is Rs 240 and its EPS forecast for the year is Rs 8, then the PE for Xlerate is 30. However 30 per se means nothing; it doesn't signify if the P/E is high or low and whether one should buy Xlerate stock.
To take that decision, one needs to compare the P/E to other stocks in a comparable category or industry. So if most other stocks in the biotech industry have P/Es of around 40, then Xlerate could be undervalued - given its P/E is 30 and lower than the industry average, and hence its 'valuation seems attractive'
However there could be two reasons why the market has priced it lower than the rest of the companies in its category: Either the major local and global investors are unaware of the company and its performance and hence haven't been able to value it correctly, or they think the stock purposely ought to be priced lower than competitors due to reasons like bad management, expected slowdown in performance, inadequate ability to deal with future/competition, etc.
Similar to a stock, foreign institutional investors who have allocations for various countries also compare India (the major indices - Sensex and Nifty) to that of other emerging markets.
If most of the other emerging market indices P/E s are at around 12 and India's P/E is at 17, then India is considered 'expensive'
Hence P/Es of companies or countries should be compared to their industry/category average to understand if they are cheap and hence attractive, or overvalued and hence expensive.
III. Advance tax numbers indicate robust quarterly corporate earnings
Think of it as the old gypsy woman reading tea leaves to predict your future except that advance tax payments are a far more reliable tool of estimating the state of the country's corporate performance. Companies pay tax in four installments during the year. The four deadlines are the 15th of June, September, December and March. The tax paid in the first three installments is referred to as advance tax. Since companies pay tax on the profits they make, higher tax payments indicate that the company is performing well and on its way to recording higher profits. Hence advance tax payments indicate all is well with the corporate world. Typically market observers track advance tax payment this year vis-a-vis the last and if it registers a rise, it indicates that companies are going to post better results this year.
IV. Liquidity is tight
A favourite of the pink papers, this phrase is used generously by journalists across the stock, debt and commodities markets. Liquidity refers to amount of money floating in the system and which is available to corporates, government and individuals. The country's central bank, the Reserve Bank of India creates money in the system. It also reduces the amount of money in circulation by sucking up money from the system either by buying rupees from banks and selling them foreign currency, or by issuing government securities which banks and institutions subscribe to. The RBI is therefore the controller of liquidity. Liquidity can become 'tight' when there the demand for funds far exceeds the supply. This could happen due to a variety of reasons:
And the usual repercussion of tight liquidity is increasing interest rates
V. Market is currently overbought
How many times have we read the business papers and thought: Did all the players in the stock markets bunk English classes in school? Why else would they use words like overbought or oversold? Then it dawns on us; these are technical terms and we don't really understand them. It's not their English; it's our financial market knowledge that's at fault.
Simply put, the market being overbought means that the market has risen too much or too fast and is 'expensive' (refer issue #5 for understanding valuations). Likewise, oversold means that the prices have fallen too sharply.
The terms per se are used by technical analysts - analysts who chart price movements to predict what the future price of the stock is likely to be. Usually there is a fair degree of balance between buyers and sellers in the market. However sometimes certain imbalances are triggered and there might be too much buying or too much selling. These are unnatural conditions and often an indicator that one must take the contrary action. Hence if the market is considered overbought, the technical analyst will sell, and if the market is considered oversold, she will buy.
VI. Risk weight age on these assets is 150per cent
Risk is key to all investments. Banks are required by law to maintain a particular level of capital to ensure that if the bank's assets or loans go sour, there is enough capital to back it up and depositors' monies are protected. This level is called the Capital Adequacy Ratio (CAR) and the Reserve Bank of India (RBI) has set it currently at nine per cent of risk weighted assets for all commercial banks; which means that if the bank lends Rs 100, it has to maintain Rs 9 as capital.
Apparently, one jargon leads us to another. It definitely is the maze we've all come to expect of the world of investments and finance. First it was CAR and now Risk Weightage. So what does risk weightage mean?
The loans or investments a bank makes all carry a particular level of risk - the risk of default. RBI requires that banks classify their assets (loans and investments) according to the risk they carry.
So typically government securities carry zero default risk since they are backed by the government. Hence the risk weightage assigned them is zero. So technically if a bank had invested all its money in government bonds, it would not be required to maintain any capital since there is no risk. If a bank lends to corporates, then those loans need to carry 100 per cent weightage. So the bank will maintain 9 per cent of the value of the loan as capital. If risk weightage on assets is 150 per cent, then banks are required to maintain Rs 13.5 of the value of the loan/investment - calculated as 150 per cent of 9.
Banks which have low capital (equity and reserves) prefer to invest a significant portion of their money in gilts since any investments in risk weighted assets means that they would have to raise more money as capital to back up those assets.
VII. Market in a bear hug
Bears represent market players who keep prices down while a bullish market represents rising prices. This is easier to visualise and understand from a popular myth which says that the terms are derived from the way the animals attack a foe - bears attack by swiping their paws downward and bulls toss their horns upward. Though the imagery helps in understanding the terms, it is but mere myth.
According to the The Wall Street Journal Guide to Understanding Money and Markets, the story behind the terminology of Bears and Bulls is as follows:
'Bear skin jobbers' were known for selling bear skins that they did not own; i.e., the bears had not yet been caught. This was the original source of the term "bear." This term eventually was used to describe short sellers, speculators who sold shares that they did not own, bought after a price drop, and then delivered the shares. Because bull and bear baiting were once popular sports, "bulls" was understood as the opposite of "bears." i.e., the bulls were those people who bought in the expectation that a stock price would rise, not fall.
Hence if you read the markets are in a bear hug, you can be sure that your stocks are not going to be moving up in a hurry.
VIII. There was some unwinding of long positions in the futures market....
This statement contains far too much jargon for even us those of us with above average IQ, but no one said that the world of investment was anywhere close to being easy. It's probably easier to learn two foreign languages simultaneously than decipher finance's complexity. So baby steps on this one:
Futures market
This market refers to contracts where the buyer and seller agree to transact at a future date; the price and quantity for that future transaction is however fixed in the present. Think of a futures contract as an understanding you would get into with your local raddiwallah. You promise the raddiwallah that you will give him 5 kilos of newspapers every month over the next six months. The raddiwallah in turn promises to pay you Rs 5 per kilo. So basically the two of you'll have entered into a futures contract where the price and quantity has been pre-fixed regardless of what the price of second-hand newspapers will be in the coming months. Both the parties benefit: The raddiwallah is locking in a guaranteed supply of newspapers, whereas you are guaranteed you will get a good price for the next 6 months.
Similar such transactions take place in the stocks and commodities markets. People tend to enter into futures contracts if they think the markets will be volatile in the future. By agreeing to price and quantity now, they can control their risk.
Long positions: When an investor holds a long position, it means that he actually holds the share and intends to hold it for a while because he thinks prices will go up on the share. If prices go down, then the investor loses money. Similarly, a long position in a futures contract, means the person is required to buy the share at the future date. She will make money if the share price goes up at a later date.
Unwinding: This refers to the process of selling to liquidate long positions
Hence this apparently Greek sounding line 'There was some unwinding of long positions in the futures market' basically means that investors think the market is likely to go down in the future and hence are selling their underlying shares and offloading their long positions.
From the turn of the century, the industry has been growing at 20 per cent per annum. And it is estimated that in the coming years, Indian banks are expected to grow at 35 per cent per annum.
In a growing economy, this sector is a direct beneficiary. What's even better is that its net non-performing assets (NPAs) have come down considerably from 8 (in the year 2000) to 1 per cent today.
To fund this growth, banks would need funding to the tune of $14 billion. This is one of the reasons the Reserve Bank of India (RBI) is opening up the sector to foreign players next year. From 2009 onwards, foreign banks would be allowed to acquire up to 74 per cent of any Indian bank.
The domestic players will benefit from the essential capital and expertise while the foreigners would get a foothold into this lucrative sector (for new players) and have the ability to reach a larger audience (for the existing ones).
In recent times there has been considerable investment by international banks like Citigroup, HSBC, Bank of America and Deutsche Bank to scale up their operations in India. Moreover, foreign institutional investors (FIIs) are also betting on this sector. As many as five public sector banks (PSB) have exhausted their limit of FII investment, with three more along with four private sector banks in the caution zone.
The only way out for FIIs is to now tap the banking exchange traded funds (ETFs) and sector funds focussed on the banking sector. This could explain why in the past 12 months the average monthly growth in the units of equity banking funds has been around 24 per cent.
At present, there are three open-ended equity banking funds in the market, while another two should be available for investment soon. Four more are still in the approval stage. But each of the existing three have their own character, the similarity begins and ends with the common sector.
Their investment strategy, market cap preference, choice of scrips and type of stocks vary. And these banking sector funds don't have a mandate limited to pure banking players. Financial institutions and brokerage stocks also find a place here.
While we look at the three equity funds in our analysis, there are also three ETFs available for investment. Like its cousins in the equity category, the Banking BeES, the largest ETF has rewarded its investors by giving a return of 36 per cent since inception.
So if none of the equity funds appeal to you, you could even look at this option. All said and done, this sector deserves a presence in any portfolio.
JM FINANCIAL SECTOR FUND – UP AND DOWN
The newest entrant to the pack got itself noticed in the very first year of its existence. Though it trounced the competition in 2007, its performance was not consistent all the year through. And while investors celebrated with a 95 per cent return in 2007, in the March 2008 quarter they had to grapple with negative returns of 33.36 per cent.
It can be argued that the fall was the logical outcome of the entire sector plummeting and the market going downhill, but JM Financial fell harder than its peers (Reliance fell by just 22.26 per cent).
This fund has always been very bullish on ICICI Bank. Soon after launch, this scrip cornered 32.49 per cent of the portfolio. It is the only stock in the portfolio that has been there continually since launch. Even now, it is the top-most holding at 11.57 per cent.
The fund manager chases growth so momentum stocks like Reliance Capital, Indian Infoline and Srei Infrastructure are more favoured than stocks like Bank of Baroda, Corporation Bank and Federal Bank which are prominent in the portfolios of the other two funds. It has more or less avoided public sector banking stocks like Maharashtra Bank, Jammu & Kashmir Bank and South Indian Bank.
Though the fund manager continuously held on to stocks like ICICI Bank, HDFC Bank, Yes Bank, IDFC, PFC and Mahindra & Mahindra Financial Services for fairly long periods of time, it does not indicate that he adheres to the buy-and-hold strategy. He has entered and exited stocks like Axis Bank, Bank of India, IDBI, Karnataka Bank, Kotak Mahindra Bank and
Reliance Capital only to once again get into them at a later date. Of course, the small size of the fund has given the fund manager the leeway to be a nimble player.
This investing style of chasing growth and selling once a price objective has been achieved, only to re-enter later, is typical of fund manager Sandeep Neema.
But what's also typical is that when his fund outperforms, it is streets ahead of the competition, but when it does not, it falls much lower than its peers. If you are considering this fund, get mentally prepared to ride the ups and downs.
RELIANCE BANKING FUND – STEADY RETURNS OVER TIME
As the oldest and largest banking sector fund, it has not disappointed investors. Over the past five years, it has delivered an annual return of 42 per cent. Historically too, this fund has been less volatile than its peers or its underlying index.
Despite being a good performer, the fund took second place to JM Financial in 2007. In the December 2007 quarter, Reliance Banking delivered 19.43 per cent as against 28.52 per cent of JM Financial. But in the following quarter (March 2008), Reliance Banking fell by just 22.26 per cent, as against JM Financial's fall of 33.36 per cent.
The reason was two-fold. Reliance Banking stayed away from high PE stocks — Axis Bank, HDFC Bank, Yes Bank, Cholamandalam DBS Finance and Srei Infrastructure. As a result it lagged in 2007 but fell much less when the market tanked.
Reliance Banking's high cash component also proved to be a buffer when the market fell. Like all the sector funds from Reliance AMC, this one too has the leeway to go fully into cash, should the need arise.
While it has not exercised that option, it does have the tendency to hold larger cash positions than its competitors. Its cash component had consistently increased from 14.52 per cent (November 2007) to 32 per cent (February 2008). Since January 2008, it has averaged at around 25 per cent.
In March 2008, when the prices fell and valuations looked to be more reasonable, the fund manager picked up Axis Bank and Kotak Mahindra Bank which he avoided earlier because they were too expensive.
What's interesting about this fund is its penchant for broking stocks — India Infoline, Indiabulls Financial Services, IL&FS Investsmart and Motilal Oswal Financial Services. But financial institutions stocks like IDFC and IFCI are not courted.
What we like about this fund is its consistency. The fund manager's strategy may not deliver headline grabbing returns but it has led to a solid record over the long haul.
UTI BANKING SECTOR – IN LINE WITH INDEX
UTI Banking Sector has been, by and large an average performer.
Fund manager Gautami Desai has not been an opportunistic investor and prefers to invest in large banking stocks. This fund has avoided brokerage stocks and prefers financial institutions like Power Finance Corporation, LIC Housing Finance and IDFC.
This strategy has certainly not resulted in the fund shooting out the lights and last year it was behind its peers in terms of returns. And what was even more disappointing was that in the recent bear run it fell by 30.16 per cent, compared to Reliance Banking Fund's -22.26 per cent and JM Financial Services -33.36 per cent returns (March 2008 quarter).
What's amazing is that when UTI Banking Sector is compared to a banking exchange traded fund Banking BeES - there has barely been any addition of alpha. The two-year annualised returns are around 32 per cent, while Banking BeES delivers a higher three-year return. So logically, why would an investor pay 2 per cent more as annual expenses (with this sector fund) when the return is virtually identical?
As a kid, I had this toy that worked on the principle of balancing. It had two arms and no matter what contortions one subjected it to, it would sway, swing, wobble and come to a stop in the upright position.
It’s the same with the market — equilibrium would be reached as the various constituents act out their parts sensibly and the valuations are discovered, after factoring in all that is known - I have since realised.
Mutual funds are a very important component of the investment landscape. They act as a buffer between the investors and the stock market and reduce the risk by diversifying the investment, offering the services of a professional fund manager, ensuring liquidity at all times, etc.
But somehow, mutual funds have been portrayed as villains by the media and Sebi also seems to see the industry as fleecing the investors, which is unfortunate. The no-load-direct mode, introduced a few months back, was touted as a great step forward for the investors.
And now, there is this proposal to legitimise passback of commission, so they can legitimately get back some of the money their distributor earns. Also the investor may benefit.
But, that being the case, why are so many unit linked insurance plans (Ulips) being sold, where the first-year charges can be well over 70%? These schemes have so many charges, and are so well-packaged, that even people from financial services often fail to decipher them.
On top of it all, innovative handling of queries on charges and mis-selling are par for the course for insurance agents. After all, they earn double-digit commissions for a product that looks like a mutual fund scheme and offers insurance as an after thought.
Wouldn’t it be in the investors’ interest to be allowed to go direct in insurance plans, too? Clearly, that would allow them to save on a lot of costs. Also, unlike in MFs, one cannot change the agent easily in insurance.
When insurance companies are allowed a free run, why is the market regulator after the mutual fund industry? The question is pertinent because although these are competing products, there is no restriction on the charges on insurance.
Representations of the Association of Mutual Funds of India for a higher allowance of expenses to create a level playing field have been rebuffed. This is a problem with having multiple regulators rather than a single one for all financial services.
Given the disparity, MF distributors would gladly start selling Ulips, for they can earn a lot more there. The individual MF advisor earns 2-2.25% from selling MF schemes, on which he has to pay service tax, income tax and meet sales and operational costs. At the end, he may be left with barely 40% of the gross commission.
Intermediaries need to earn. An industry will remain healthy and vibrant only if the constituents are able to earn reasonable returns. Why else would be there in the first place?
But, clearly, the regulators do not think this applies to the mutual fund industry. Going by them, these players need to be controlled and disciplined as opposed to being just regulated. That’s a flawed premise.
Take the telecom industry. When it was government controlled, one had to register for a phone and wait endlessly. All that changed with the arrival of private operators and the ensuing competition. In a matter of years, the charges have come down from Rs 16 a minute to as low as 10 paise a minute.
This was achieved by creating an ecosystem with healthy competition, not by passing a diktat. Throttling the players with legislation would have killed what has grown into a vibrant industry and a major employer.
That’s precisely what the mutual funds industry needs, too. The regulator could look at other ways of deepening the market, broadening the reach and protecting investors’ interests.
The following constructive measures may be considered:
The regulator could look at ensuring that MF money stays invested longer, so people start participating in the growth story as investors, rather than buccaneers.
Introducing punitive exit loads, of say 5% for exits less than 12 months, could ensure that investors develop a long-term outlook, which is good for the industry and the economy at large. This will curb churning and ensure that investment in mutual funds is not 'hot money' that keeps moving in and out, such as those of the hedge funds.
This will bring stability in the market and give the fund manager the stability he needs to do his job properly, without constantly looking in the rear view mirror, for signs of redemption pressures.
Long-term investors can be incentivised. Lower expense ratios (of say, a maximum of 2.25% as opposed to 2.5%) for those staying invested for three years or more can be a tangible incentive.
Lastly, the anomalies should be corrected. When there were loads, the distributor was not expected to invest in his name and if he did, he had to inform that he was doing so to exclude those investments from commissions. Now that the no-load direct option is in, this system is redundant. Yet this continues.
It goes without a saying that equilibrium would eventually be reached, much like the toy I had. Only, whether it would be in the interests of the investor is another matter.
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